Less than a week after the EU ETS revision officially concluded, a group of Member States are already moving ahead with the debate on additional carbon pricing in the EU. Last week the French Government organised a side-event to the Environmental Council of Ministers to discuss the idea of a regional carbon floor initiative. In doing so, the French are living up to the climate leadership mantle they have well established for themselves. Sandbag was invited to present to this select audience and to share our views on the benefits and challenges of such an initiative. This blog will cover the contents of our presentation.

Political backdrop

The idea for this event came in response to the climate topic being dropped from the agenda of the EU’s Environmental Ministers Council on the 5th of March, most likely as a response to both EU carbon budgets (the EU ETS and the ESR) having completed their revisions in 2017. The implication was that there is no longer a need to discuss emission reduction obligations in the EU. However, many seem not to share this view. Judging by the impressive representation of countries and large audience last week’s event gathered in a record time, there’s awareness that the ETS revision may not be ‘job done’ for EU carbon pricing and we can conclude that there is continued interest in advancing climate ambition in the EU.

While the timing of the event – just one week after the final approval of the ETS revision – might seem odd, it is perfectly sensible. Firstly, we have full visibility on reduction obligations and the framework meant to deliver them for the whole next decade and as many have pointed out at the event, we will be doing too little, too late. Secondly, there is much awareness that the opportunity to include an automatic ratchet, which would have aligned the ETS with the Paris Agreement principles and timeline, was missed. Thirdly, despite the reforms, there’s also still a significant risk that the surplus will remain above a billion out to 2030, depressing the carbon price.

Last but not least, with the revision concluded, the more ambitious Members States which might have felt displeased with negotiations which catered too much to the least ambitious in the EU, finally have the chance to move ahead with policies that would better reflect their positioning. This is a very clear indication that the final result landed much closer to the preferences of the non-ambitious Member States, than it actually resulting in a ‘”balanced outcome”. Moving ahead with backstop measures, such as a regional carbon floor price initiative, make perfect sense against this backdrop and would save the EU both time and investment capital going ahead in the direction of implementing the Paris Agreement and the extremely high level of ambition this would actually require.

Why a regional carbon floor price?

Additional reductions – The EU ETS now contains a helpful cycle of emission reductions and surplus cancellation through the MSR

The EU ETS Phase IV Revision gives Member States a credible framework to pursue additional emission reductions in the ETS sectors through national policies. With an increase in the MSR intake rate, in conjunction with a cancellation from the Reserve, the impact of additional emission reductions on the growing surplus, would be diminished.

This helpful developed means that we can park the whole discussion on the “waterbed effect” and move on to adopt actual policies needed. But will more policies be needed?

With the current design, emissions could still be above the point-end target set for the EU, assuming emissions follow a base case scenario.

While there seems to be agreement amongst the analysts that price will pick up, there is still high uncertainty on whether or not the level of 30 €/tonne – widely recognized as the optimal level to achieve a cost effective decarbonisation and coal phase-out for Phase III – will be reached by the end of Phase IV – let alone much higher carbon prices which are likely necessary for decarbonisation in other sectors

So there’s a strong case for a safety-net policy that ensure prices don’t drop below a certain level deemed as the lowest appropriate to drive the transition. A carbon floor policy would be the safest option and it would also mean that in the case that prices do reach a relevant level, it would cease to apply. This would simply ensure that the irrelevant carbon price of most of Phase III doesn’t get repeated and that prices are kept sufficiently relevant for the Member States committed to decarbonisation to be able to plan their decarbonisation map alongside reliable prices.

Case Study I : Carbon floor pricing in the UK

The UK carbon price was introduced in 2013 for fuels used in power generation and consists of two elements: one is the EUA price and the second is the Carbon Price Support (CPS) which has a floor. The price floor is set by the level of the tax, as this would remain even if the EUA price fell to zero.

The initial CPS level was set 5£/tonne with an upward trajectory to £80/t total carbon price by 2030. This proved to be too expensive, so since 2016 it’s capped at £18 per tonne, transforming it essentially into a fuel duty tax.

The impact has been extremely beneficial in 3 directions:

Emissions from coal dropped by 84% in the UK from 2012-2017. Per annum this amounted to approx. 50 mil t/p.a. and it made the UK the advanced economy with the highest percentage of per capita emissions reductions

In addition to this, the UK CPS increased renewables profitability. Projections show that by 2025 the UK will be producing as much electricity from renewables as it was from coal just a little over a decade before, meaning that a 100% transition from coal to renewables will have been achieved.

Lastly, the revenues generated by the CPS to the UK Treasury are considerable, amounting up to £500mil/year, on average, with some of the initial years leading to even £1bn revenues.

There’s a problem on the horizon for the UK though. In the next 4 years, 12GW of new interconnectors will be built to connect the UK with Norway, Denmark, Belgium, and to increase connection with Ireland, France and Netherlands. If neighbouring counties do not increase their carbon price, it is possible that the UK will not be able to maintain its carbon floor price at the same level.

There is another reason, though, that regional carbon floor price makes sense. The same group of countries are expecting a massive surge in renewable electricity, primarily using the North Sea resource, which they share.

According to the latest projections from the UK Government, all of this might be of risk, as the UK foresees that 22% of its electricity will be imported by 2025. With interconnectors from the UK to continental Europe bound to increase 4 times in the next 4 years, this example does seem to indicate that countries wanting to move ahead with this move are best advised to do so at the regional level.

This area is favoured in terms of potential for low-cost offshore wind, making use of economies of scale (all green areas on the map indicate potential locations for such projects). A regional carbon price floor would support such a development. It would also make carbon pricing extendable to other geographies or sectors. Such an arrangement would best function with Germany involved in this development as well, but of course other countries could join with time. Pursuing this regional piece, would also enable this region to undergo the electrification of transport at the same time with the decarbonisation of the electricity sector.

Conclusion

The ETS revision has made a great step in the right direction, by introducing a helpful mechanism which correlates emission reductions with surplus cancellations. However, the delay the current revision will bring on delivering an appropriate level of carbon pricing means that additional ‘Safety-net’ policies will have to be introduced.

A regional carbon floor would be ideal and it would achieve several policy objectives in one go. If set at an appropriate level, it would substantially reduce high carbon generation. It would further support unsubsidised renewables roll-out and it would unlock the potential for offshore wind, while limiting carbon leakage in the electricity sectors. This would also generate revenues which could minimise the short-term impact of such a pricing mechanism on electricity bills to citizens.

As such a policy is extendable to other geographies and sectors, this one step forward at this stage could also get the region and the EU closer to pursuing other more ambitious projects in a safer environment (i.e. electrification of transport).

Sandbag remains committed to monitoring and contributing to this debate as it moves forward.

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